Actuarial Notes

Reasons for Insurance Regulation

Study guide: Exam DISC-IA

The Reasons for Insurance Regulation in the United States come down to protecting consumers: an insurance policy is a promise to pay later, written by the insurer, that the buyer can't easily evaluate, so the states supervise insurers' solvency, how they sell, what their policies say, what they charge and how they settle claims. The states do this under the McCarran-Ferguson Act, which leaves the business of insurance to state law, and they coordinate through the NAIC. The Canadian counterpart, with its federal and provincial split, is Insurance Regulation.

\text{A federal act overrides state insurance law} \iff \text{it specifically relates to the business of insurance}

  • The rule above: The McCarran-Ferguson Act of 1945 declares that continued regulation and taxation of the business of insurance by the states is in the public interest. No act of Congress is to be read to invalidate, impair or supersede a state law regulating or taxing insurance unless the act specifically relates to the business of insurance. The federal antitrust laws apply to insurance only to the extent state law does not regulate it, and agreements or acts of boycott, coercion or intimidation remain subject to the Sherman Act in any case. Since a 2021 amendment (15 U.S.C. 1013(c)) the exemption no longer covers the business of health insurance, including dental insurance. The history is on History of Insurance Regulation and the current federal role on State and Federal Insurance Regulation.
  • Consumer protection: In the NAIC's account, government regulation of insurers and producers began in the states for one overriding reason, to protect consumers. The most important protection is making sure insurers remain solvent so they can pay claims. Beyond that, states supervise sales and marketing practices and policy terms and conditions so that consumers are treated fairly when they buy insurance and when they file claims.
  • Market imperfections: Economists justify regulating a business only where there is a demonstrable market failure, measured against a reasonably competitive market, and where the benefits exceed the costs. Since most insurance markets are competitive, the main economic rationale is to reduce how far insurers or producers misrepresent what is being promised at the sale, or fail to keep the promise through insolvency or deficient claims settlement. That calls for solvency oversight, and for some oversight of sales and claim practices to supplement market discipline and the buyer's remedies in contract and tort.
  • Contracts the buyer can't negotiate: A policy is a contract of adhesion, drafted by the insurer and offered on a take-it-or-leave-it basis, which is why regulators review policy forms and readability (Policy Form Regulation) and courts construe ambiguities against the insurer.
  • Harm to others: Some insurance is compulsory because an uninsured loss falls on someone else. Compulsory auto liability insurance reduces the number of uninsured motorists and the costs they impose on other people.
  • Limited guarantees: If an insurer fails, state guaranty funds pay part of its obligations through after-the-event assessments on other insurers. Keeping the protection limited preserves policyholders' reason to buy from sound insurers, which full guarantees would weaken.
  • The state-based system: Each state licenses insurers and producers, reviews rates and forms, examines insurers' finances and market conduct, and the domiciliary state leads solvency supervision (Insurance Regulator). The NAIC, governed by the chief insurance regulators of the 50 states, the District of Columbia and five territories, sets standards and best practices, conducts peer reviews and coordinates oversight. Its model laws bind no one until a state enacts them, and its financial reporting rules and accreditation program are how the states achieve uniformity in solvency regulation.
  • Reason to tool: Solvency is protected by licensing, solvency monitoring and guaranty funds. Fair dealing at sale and at claim is the job of market conduct regulation and unfair claims settlement laws. Rates are held to the standards of state rating laws, and contract wording to policy form regulation.

Matching a Problem to the Reason and the Tool For each problem, name the reason for regulation it engages and the regulatory tool that addresses it.

  1. A buyer can't judge whether an insurer will still be able to pay a claim in ten years.

  2. A producer tells a retiree that a policy pays benefits it does not.

  3. An insurer routinely pays claims only after policyholders sue.

  4. A policy's coverage is decided by a clause no ordinary buyer could understand.

Answer

  1. Solvency. Licensing standards and solvency monitoring, with guaranty funds as a limited backstop.
  2. Misrepresentation at sale. Market conduct regulation under the state's unfair trade practices law, and producer licensing, which lets the commissioner suspend or revoke the license.
  3. Failure to keep the promise through deficient claims settlement. The unfair claims settlement practices law, enforced through market conduct examinations.
  4. A contract the buyer can't negotiate. Policy form review and readability requirements, with the courts construing ambiguity against the insurer.

Does Federal Law Displace the State's? (a) Congress passes a statute of general application that, read literally, would conflict with a state law regulating how insurers handle policyholder records. The federal statute says nothing about insurance. (b) Several insurers agree among themselves to refuse all business from producers who also place business with a new competitor. Which law governs each?

Answer (a) The state law. Under McCarran-Ferguson, a federal act does not supersede a state law regulating the business of insurance unless the act specifically relates to insurance. (b) Federal antitrust law. The antitrust exemption reaches only conduct the state regulates, and an agreement to boycott is always subject to the Sherman Act. The same agreement is also an unfair trade practice under a state law based on the NAIC Unfair Trade Practices Act.

How it appears on the exam

  • DISC-IA: The Insurance Regulation section opens with the reasons for insurance regulation. Questions ask why insurance is regulated, which reason a given rule serves, how McCarran-Ferguson divides state and federal authority, and what the NAIC does and does not do.
  • Applied questions: A question describes a consumer problem and asks which reason for regulation, or which regulatory activity, addresses it, as in the first example.

Exam traps

  • Solvency first: Regulators name solvency as the most important consumer protection. An answer that puts low premiums first misses that a rate too low to cover costs is itself a solvency problem.
  • The NAIC is not a regulator: It writes model laws and coordinates the states, but a model binds no one until a state enacts it, and the NAIC licenses and examines no insurer.
  • McCarran-Ferguson is not a full antitrust exemption: Insurers are exempt from federal antitrust law only where the state regulates, and boycott, coercion and intimidation are never exempt. Since 2021 health insurance is outside the exemption altogether.
  • U.S. versus Canada: In the United States the states, led by the domiciliary state, supervise solvency. Canada splits solvency (OSFI) from market conduct (the provinces), which is on Insurance Regulation.